Private equity

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WHENEVER savvy private equity firms sell debt in the companies they own, buyer beware.

That’s the lesson — learned the hard way — for bondholders in Wind Hellas, a Greek mobile phone operator whose parent company defaulted on some of its debt payments last November.

A once-healthy company that is Greece’s third-largest mobile phone operator, Wind Hellas was taken over in a 2005 buyout by two global private equity giants: Apax Partners out of London and the Texas Pacific Group, led by David Bonderman. The two firms larded Wind Hellas with debt before selling it off just two years after they bought it.

Wind Hellas filed for the British equivalent of bankruptcy protection last fall, and now some investors are trying to figure how such a promising enterprise went aground. Apax and T.P.G. officials declined to comment for this column.

But Bertrand des Pallières, the chief executive of SPQR Capital, a London investment firm, was one of the larger bondholders in Wind Hellas. He says the decision by Apax and T.P.G. to heap debt onto the company while simultaneously extracting so much cash from it ultimately contributed mightily to its woes.

“The private equity industry always pitches how constructive it is as an investor force to create jobs and growth,” says Mr. des Pallières. “But there are private equity funds that get rich by breaking companies and making others poor — whether they are creditors, states or employees.”

When the deal to buy Wind Hellas — then known as TIM Hellas — was struck in 2005, the buyers gave it a nifty code name: “Project Troy.” Apax and T.P.G. paid 1.1 billion euros for 81 percent of the company; later that year, they paid 264 million euros more for the rest.

At the time of the buyout, TIM Hellas was a young company with a history of operating growth, regulatory filings show. From 1999 to 2004, the year before the buyout, cash flow at TIM Hellas grew almost 17 percent, annualized. It generated cumulative earnings of 283 million euros for the years 2001 through 2004, and by the time of the deal was serving 2.3 million customers.

The company had little debt — 166 million euros — before the buyout and boasted shareholder’s equity of almost 500 million euros. Then Apax and T.P.G. came calling.

Major banks, including JPMorgan Chase, Deutsche Bank, Lehman Brothers and Merrill Lynch, financed Project Troy. Apax and T.P.G. put approximately 450 million euros into TIM Hellas as equity, but this money was returned to the firms less than a year later after the phone company issued a round of debt.

The private equity firms also received consulting fees worth 2 million euros per year, company filings show. In addition, Apax and T.P.G. received 15 million euros for “business advisory services rendered in connection with debt placement and preparation of business and strategic plans,” according to the company’s 2005 annual report.

Under its private equity owners, TIM Hellas took on debt immediately. By the end of 2005, the company was carrying 1.26 billion euros in long-term debt, almost eight times the level a year earlier. Then came the bond offering of 500 million euros in April 2006 that let Apax and T.P.G. get their money out of the company. After that deal, Standard & Poor’s cut the company’s debt rating to B, citing “the significant increase in leverage and material weakening of free cash flow.”

Still another trip to the debt markets for TIM Hellas occurred in December 2006, when it raised roughly 1.4 billion euros. By the end of that year, the company’s debt load had grown to over 3 billion euros, 20 times the level of two years earlier, before the buyout.

At the same time, the company’s financial performance was declining. Net income at the company rose from 35.9 million euros in 2001 to almost 80 million in 2004 but shifted to losses in 2005. From 2004 to 2008, the company showed losses totaling 155 million euros.

Perhaps the most interesting part of this tale involves a transaction that occurred around the time of the December 2006 debt offering. In that deal, 974 million euros — out of the 1.4 billion euros raised in the offering — went from the company to Apax and T.P.G. The prospectus for that transaction described the 974 million euro payout as a repayment of “deeply subordinated shareholder loans.”

But at the time of the offering there weren’t any such “shareholder loans” listed on the company’s balance sheet. In other words, the company was paying back Apax and T.P.G. for loans that were listed as equity rather than as debts at TIM Hellas.

ADDING to the mystery, the repayment was made using a peculiar transaction involving the redemption of “convertible preferred equity certificates” that TIM Hellas had issued. These exotic securities can be accounted for as debt or equity, an option that allows companies that issue them to choose whichever category gives them the most tax advantages in a given country. TIM Hellas classified the certificates as equity.

TIM Hellas had issued such certificates when it was bought out in 2005, and as of April 2006, each certificate carried a value of 1 euro, according to the company’s filings. The company’s 33.8 million certificates outstanding as of September 2006, therefore, had a value of 33.8 million euros.

Company filings from September 2006 seemed to assure potential bondholders that TIM Hellas could redeem these certificates at prices greater than par value or market value only when “the company does not have any other debt liability to pay or to provide for with priority” to the certificates.

On Dec. 21, 2006, however, the certificates were redeemed to pay back those mysterious “shareholder loans.” And they were redeemed for 35.6 euros each, which generated the 974 million euros used to pay Apax and T.P.G.

Just 10 days later, as 2006 was drawing to a close, the value of the equity certificates fell back to 1 euro each, according to company filings.

Why did the certificates suddenly spike in value? Neither Apax nor T.P.G. would say. But their lofty price, according to the debt prospectus accompanying the transaction, was determined by a friendly crowd: the directors of one of TIM Hellas’s own subsidiaries.

These board members weren’t identified, but at the time the board of TIM Hellas itself was very clubby. It consisted of 10 people; six were employees of Apax and T.P.G., and two were company insiders. The other two directors were independent.

In February 2007, less than two months after Apax and T.P.G. snared the windfall from their certificate payout, the firms sold TIM Hellas for 3.4 billion euros in equity and debt.

Last fall, the parent company for the mobile phone operator now known as Wind Hellas defaulted on some of its debts, an unhappy situation that has left Mr. des Pallières, the investor, shaking his head.

“Private equity and banking can be very constructive functions of the economy, but they will destroy this industry if the leading players do not regulate themselves,” he says.

It’s yet another tale for our times.

Debt loads expose private-equity game

Private equity is one of Wall Street’s great euphemisms.

So-called private equity firms put up little equity when they make acquisitions. They are all about debt, gobs of it. We should call them by their proper name: leveraged-buyout firms.

LBO firms such as Blackstone Group LP, the biggest of the bunch, and KKR & Co. have even less business calling themselves private investors since they have become public companies.

The recession and its aftermath have shown once again the folly of loading up with debt at the expense of equity.

Big names in LBO portfolios like hotel chain Hilton Worldwide, casino-operator Harrah’s Entertainment Inc. and the Texas power company formerly called TXU Corp. have negotiated better terms from their lenders, or need to do so.

Not surprisingly, LBO firms, once the darlings of pension funds and college endowment funds, are having trouble raising new funds to do more takeovers.

They took in only $13 billion of new money for buyouts in the first quarter, compared with a peak of $68 billion in the first quarter of 2008, according to Preqin Ltd., a London research firm.

Leveraged buyouts were conceived to take public companies private at a premium to market value with mostly borrowed money, then milk the targeted companies for management and advisory fees and finally take them public again in about five years -- and score a big capital gain.

No Relief

In their current sad state, LBO firms can’t increase their fees much by making more acquisitions and the poor results of companies they own has diminished the potential of reselling them at a profit. Blackstone, which also has real estate funds and investments in hedge funds, reported a net gain from investments of $176.7 million in 2009, a decline of 97 percent from $5.42 billion two years earlier.

Blackstone, founded by former U.S. Commerce Secretary Peter Peterson and Chief Executive Officer Stephen Schwarzman, sold stock to the public in 2007 at $31. Its average share price since then has been about half that amount.

Last week, Blackstone managed to reduce the debt load at its Hilton chain by $3.9 billion, to about $16 billion, and extend its maturity by two years to 2015. Hilton bought back $1.8 billion of debt and converted another $2.1 billion into preferred equity.

Gone Begging

Twice since it was bought in 2008 by TPG Inc. and Apollo Management LP, Harrah’s Entertainment has managed to talk lenders into cutting the amount it owes and giving it more time to pay.

Apollo recently reduced the value of its Harrah’s stake by $152 million, to $884 million, according to a letter sent to Apollo’s clients. At the end of 2009, Harrah’s had $18.9 billion in long-term debt, against only $1.78 billion in equity. The curse of leverage will continue.

TXU, now called Energy Future Holdings Corp., was bought by TPG and KKR in 2007 in the biggest LBO ever, about $43 billion. It now may be the biggest LBO headache ever. Bonds sold by the utility due in five to seven years have been trading at about 72 cents to 78 cents on the dollar.

All’s not lost for LBO firms. KKR was able to sell a small stake in Dollar General Corp., a discount retail chain, last November at $21 a share. The stock traded as high as $27.01 last week.

Carlyle Group, the second-largest LBO firm, has raised $1.1 billion to buy distressed financial companies. The money will be managed by Olivier Sarkozy, half-brother of French President Nicolas Sarkozy.

These investment outfits no doubt will regain their popularity one day. But never forget that their trade is risky leveraged buyouts. Leverage as in debt, debt, debt.

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